Front-Loading borrowing best option

ET Bureau|

Jul 18, 2009, 05.17 AM IST

The only thing that can be said about the government���s decision to front-load its borrowings for the current year is that it is a noble attempt to make the best of a bad job. Given the gargantuan size of the borrowing programme for 2009-10 ��� Rs 451,000 crore ��� and worse, the possibility that this might well be exceeded (if the last year is any guide), the best option is to mop up as much and as soon as possible. Before the economy recovers!

For, if the stimulus package has the desired effect and economic activity picks up, private sector demand for bank credit will also increase and compete with demand for funds from government, leading to the infamous ���crowding out��� effect. And, as a corollary, to a rise in interest rates as both compete for the same pool of funds.

In contrast, if government were to complete the bulk ��� two-thirds ��� of its borrowing before private sector demand picks up, this could not only ease the pressure on funds but also set off a virtuous ���crowding in��� effect. Money spent on improving infrastructure, for instance, could spur private investment.

All this, of course, is if everything goes according to plan. Unfortunately, in the real world things seldom work according to plan. Inflation could pick up in the second half if the rains do not make up for the deficient and delayed monsoon we���ve had to date. Already there are reports of much lower output of pulses and edible oil and consumer inflation (for agricultural and rural labour) is still in double digits.

If that happens the RBI may not be able to keep liquidity easy enough to mop up the remaining one-third of government borrowing slated for the second half of the year without jeopardising price stability. Alternatively, it may have to jack up interest rates to enthuse the market to subscribe to government paper and that would raise interest rates across the board and threaten the very revival of activity that the government is trying so hard to engineer through its stimulus package.

Either way, the RBI has a tough job on its hands. Will the RBI pull it off? We���d prefer to keep our fingers crossed.